Cyber-security is one of the fastest growing areas of technology, with key trends such as the growth of cloud-based IT, the expansion of both Bring-Your-Own-Device (BYOD) and the Internet of Things (IoT) devices and new EU legislation all set to ensure that 2017 will continue to see significant buyer and investor interest in this market. Livingstone has been highly active in this sector, selling leading technical consultancies Context and, most recently, Info-Assure to major corporates Babcock and BSI respectively as well as advising on the secondary buyout of M2M enabled security services provider CSL by Iconiq.
The former two transactions are reflective of the long-run trend by which motivated corporate acquirers pay strong prices, frequently multiples of revenue, to secure strategic assets. However it is the CSL deal which highlights a potentially significant new trend – the growth of US investor interest in UK businesses in this sector.
A report published at the start of January by Get Safe Online and Action Fraud highlighted the scale of the cyber-security issue. The findings showed that businesses in the UK experienced a 22 percent increase in cyber-incidents in 2016, with a total reported loss of more than £1 billion. This figure, combined with the increased profile of data breaches last year and the impending GDPR which is set to substantially increase the penalties for data protection failures, has major businesses concerned. Companies that can deliver solutions to combat this threat are becoming highly attractive assets for investors both sides of the Atlantic.
Eyeing up assets across the pond
Iconiq is a US Private Equity fund which invests the money of several significant individuals from the west coast such as Mark Zuckerberg, Jack Dorsey and Reid Hoffman. US investors, like these who are reaching across the Atlantic to acquire market-leading technology assets such as CSL are becoming increasingly common.
For example, this year another Californian fund, Trinity Ventures, hoovered up Digital Shadows, a cyber intelligence firm. Similarly Avecto, the Manchester-based endpoint security firm, received a minority investment from JMI Equity, another transatlantic shopper. Meanwhile the headline-grabbing smart software platform Darktrace, led by the team behind Autonomy, has also received its investment from a group of predominantly US-based investors, led by KKR.
While CSL was bought from UK investor Bowmark, it is one of only a handful of companies of scale in the sector backed by UK private equity, others being Clearswift (which Lyceum has just sold to Ruag) and Secure Data (August Equity). There are a small number of assets held by successful venture capital trust managers such as YFM and Albion, as well as by a limited number of specialist investors, but overall the market share of US investors is meaningful and growing.
Weighing up UK private equity
It appears the UK private equity fund community must not be optimally placed to address a sector largely populated by very fast-growing but small businesses. Corporate acquirers with good industry knowledge are finding businesses when they are still small, and paying prices based not only on their strategy but the fundamental potential of this market and the rate of growth, often dealing with founders still young enough and ambitious enough to keep going under new ownership. This makes competition for the best assets fierce even at relatively modest scales, and to be successful PE investors need to be focussed and aggressive.
It appears that US investors which can tolerate this greater equity risk have reached maturity more quickly than our domestic market, and are now reaching into the UK as one of the next most developed IT security markets, chasing smaller deals in the knowledge that the growth potential, both organic and via buy-and-build strategies, is significant.
As we welcome in 2017, there is a very limited number of funds in the UK able and willing to compete in this dynamic market, but given the returns being achieved on exit and the strong market and legislative drivers, we expect another strong year for M&A, and an influx of US sponsors very soon.
Contributed by Graham Carberry, partner, Livingstone